Adjusting Equity Grant Practices to Respond to Stock Price Volatility

The significant drop in stock prices this year has many companies rethinking their equity grant practices to manage “burn rates” and preserve share authorizations.

We have observed several different approaches among our clients to achieve these objectives.

Different Approaches to Manage “Burn Rates”

1. Adjusting the Grant Date Fair Value for purposes of determining award sizes by using an average value—such as an annual average stock price—to better reflect the likely prices once the market stabilizes. Note that if this calculation results in a larger number of shares than historical, there will be greater leverage if the market rebounds.
2. Replacing shares with cash awards below the top leadership team—e.g., NEOs. Note that this may not be an option for struggling or cash-strapped firms.
3. Changing the mix of long-term incentive (LTI) vehicles from performance-based to time-based vehicles. Experience has shown that providing greater certainty of awards in volatile times makes executives more willing to accept fewer shares. There is an added benefit: fewer shares need to be reserved for time-based awards because there is no upside.
4. Reducing the eligibility for LTI awards to reflect share constraints while increasing the size of annual incentive opportunities.
   
5. For early-stage companies, characterizing awards as inducement awards which are not counted against share authorizations. However, these awards do need to be reported to the applicable stock exchange and in a press release. In addition, these awards would be reported as “not approved by shareholders” in the Equity Compensation Plan Information Table.
6. Targeting awards to ensure that higher value-add positions and top performers receive larger awards, especially in tight labor markets.

Companies need to take care in communicating these changes to ensure transparency and maintain trust. Communications should cover factors such as the rationale for making changes, whether these changes are temporary, and the benefits to employees where they exist (e.g., greater leverage, more certainty).

As context for decision-making, boards can consider the following before adopting a course of action:

1. How do historical burn rates compare to peers? 
2. When was the last time the board asked for an increase in authorization? 
3. Does the company have adequate cash reserves to switch to cash payouts?
4. Does the company now differentiate the size of LTI awards by individual? 
5. Will a change in LTI awards put talent at risk of leaving?